T11 Capital Management commentary for the third quarter ended September 30, 2016.
- Winning positions in September: LEHct** +41.12%, PIH +2.30%, KFS +1.06%
- Losing positions in September: WMIH -6.02%, ARIS -0.22%
- New additions to portfolio: None
- New liquidations in portfolio: None
- Portfolio exposure as of September 30th: 100% long/0% cash
- Long Positions as of September 30th: WMIH, KFS, PIH, ARIS, LEHct
T11 Capital Management – Portfolio Highlights
Since initiating the position in PIH during Q1 of this year, the company has faced two storm events in Louisiana, the most recent being the historic floods in the state during the month of August. Both events have served as a means of temporarily interrupting the positive momentum in what is an evolving company that is poised to accelerate growth and perhaps most importantly, geographically diversify their property and casualty coverage base so that future storm events in Louisiana will no longer disproportionately influence earnings.
The entire basis for investment in PIH is that Louisiana is simply a springboard for an insurance company that will eventually have policyholders in multiple coastal states with an effective methodology for underwriting policies based on the collective experience of the management team. Effective underwriting across a wide geographic base will allow for significant growth to take place in the bottomline that is not currently being recognized by the markets. In fact, a simple normal period of weather activity in Louisiana that doesn’t cause historic flooding or widespread wind damage will result in the growth in book value that is necessary for the markets to begin assigning the premium to book that is assigned to most other property casualty insurers in the space.
[drizzle]PIH is currently the lowest valued property casualty insurer in the public markets selling at a 20% discount to book value. This is due to a lack of recognition by the markets, as well as a lack of geographic diversity in policies, which is being remedied by their recent move into Texas.
The growth available in Texas alone will change the complexion of the company, which seems to be a fact that is well understood by management as they have been hiring aggressively in the region, including management positions for those who have long-term experience in Texas. 1% of the targeted policies in Texas would translate to a tripling of current premiums from policies written. The company is targeting 2-3 percent of the Texas market over the long-term.
We are effectively getting all of this future potential growth at a discount to current book value. PIH remains a classic value proposition with a substantial backstop in overall risk given what is an overcapitalized balance sheet awaiting further deployment.
KFS continued its ascent during September, with a small gain to finish the month. The stock has managed to gain 25% year to date, which given the continued difficulty in the small-cap space is not a small feat.
There are opportunities that come along in the financial markets that have various different paths towards profitability. It is difficult to gauge what that path will be a majority of a time. However, with some names, there is an early recognition of the velocity that will be involved in creating value over time.
KFS is increasingly becoming a name that has the characteristics of a company that will be a producer of capital gains in a very steady manner over a very long period of time. It has a management team, that while aggressive in the manner they have approached the restructuring of their organization over the past several years, is actually conservative and appropriately diligent in the way they approach opportunity. Everything is viewed, and this has been reiterated by management numerous times, in a very long-term lens.
It only takes a brief look into the portfolio and investing style of the key driver behind Kingsway’s turnaround and largest shareholder, activist investor Joseph Stilwell, to realize the type of return profile he enjoys, with a significant likelihood that he would want a similar return profile for his largest holding.
Stilwell is an investor in regional bank names almost exclusively, which is a sector that enjoys long-term, slow and steady appreciation during positive financial cycles. These upward cycles are interrupted very briefly for a period of months or quarters during dramatic changes in economic policy or surprising macro events. Generally, however, regional bank shares, especially in today’s economic environment where they enjoy much less of the burdens of their larger, national counterparts, are an investment that remains separated from stock market volatility, while enjoying much more steady performance.
I expect that Kingsway will evolve into a regional bank name, not in terms of their corporate business profile, but in the way the company appreciates over time. Slow and steady, with relatively minimal volatility that adds up to above average performance over time.
WMIH remains a long position in the portfolios. There were no new developments during the month of September.
ARIS was profiled extensively in the research report released during August. The rationale for investment here is extraordinarily simple: A company with the consistent ability to generate 90%+ recurring revenues within a SaaS business model that doesn’t allow for clients to cut ties with ARI Network Service’s technology solution unless they are willing to endure substantial difficulties, interruptions and expenses. That’s the core investment thesis that allows for a very low risk investment with the potential for steady gains over time, which is an investment profile that is attractive.
What elevates ARIS even further up the ladder of attractive investments currently available in the market is the two pronged nature of their strategy. The management team is extremely proficient in utilizing acquisitions as a means of furthering their market position. Since 2012 the company has completed six acquisitions.
Realizing that this a key component of their strategy, management has undertaken the task of restructuring the balance sheet by significantly reducing debt, allowing ARIS the luxury of targeting larger acquisitions that will be accretive to earnings while being non-dilutive to shareholders. This will allow ARIS to further enhance their market position, which simultaneously enhances their appeal to both private equity investors and competitors or public market companies that want an immediate advantage in the space and are willing to pay for that privilege. ARIS itself is assuredly an acquisition target over the next few years.
Additionally, the company on the SaaS front plays right into a key consumer economic trend of keeping cars for longer periods of time, much to the delight of automobile shops and parts companies. These same companies depend on ARIS software to power their consumer business. There will be no shortage of demand for their services in the coming years.
The company will be releasing earnings during October. I look forward to reviewing them in the October monthly summary.
Thoughts & Analysis
The stock market is a giant distraction from the business of investing. —- John Bogle
Let’s Get Normal
The Delivering Alpha Conference took place in September. Delivering Alpha, for those who are not familiar, is basically a conference